El Salvador

Dollars and debts

WILL El Salvador be the next Latin American country to adopt the dollar as its currency? Its conservative governments have long been enthusiastic about a currency switch. Jose Luis Trigueros, the finance minister, argues that dollarisation would boost economic growth, by eliminating currency risk and thus allowing interest rates to fall. But opponents say dollarisation would help a small group of bankers, while hurting manufacturers and exporters.

On paper, at least, El Salvador is a far more promising candidate for dollarisation than, say, Ecuador, which recently adopted the greenback out of desperation with its own, sliding, currency. By contrast, El Salvador has maintained a fixed exchange rate for a decade. It has enough hard-currency reserves to replace the local currency. And its economic ties with the United States have long been close. Not only does its giant neighbour take 60% of El Salvador's exports, but the largest single source of hard currency is the $1.3 billion sent home annually by Salvadoreans who live there.

After a promising spurt in the mid-1990s, El Salvador's economic growth rate has since sagged. Farmers and manufacturers are struggling. But, until recently, bankers have been thriving. Although prices fell last year, bank lending rates are running at a stiff 15-22%. Such rates have encouraged El Salvador's banks to borrow abroad, lending the funds on in local currency. Yet now the bonanza threatens to stop. The banks' profits are falling, and their clients are struggling to pay their debts. The strongest five banks are now buying up the rest, and expanding their business into other Central American countries.

The economic slowdown has led to calls to float the exchange rate. That is favoured by exporters, including the clothing factories which set up in El Salvador a decade ago, attracted by tax breaks. They face stiff competition from similar maquiladora factories in Mexico and elsewhere in Central America. Dollarisation is also opposed by the FMLN, the left-wing party set up by former guerrillas. It made gains in a parliamentary election last month, displacing the governing right-wing ARENA as the largest party in Congress.

But devaluation would be costly for the banks, whose hard-currency debts now stand at $500m. To their critics, the banks have enjoyed undue privileges. Though they are free to set interest rates, competition is limited. Foreign banks have been allowed unfettered access to El Salvador only since last year. The banks charge high fees for processing remittances, and pay a paltry 3-4% on most savings accounts.

Several of the banks were privatised at the end of El Salvador's civil war of the 1980s. They were supposed to be sold to their employees and the public, but in practice ended up in the hands of a small group of the country's richest families, members of ARENA. The banks' close links with the authorities were underlined last year when the central bank's president of more than a decade left his post and soon joined the largest private bank.

If it is to revive the economy, the government may have to decide either to dollarise or to devalue. If it chooses the dollar, the banks' record means that its decision may be unpopular, at least among El Salvador's producers.